When saving for college, starting early is key. Azzad advisers will help you plan for one of life's biggest investments.

Investing for Education

As someone who values financial freedom for yourself and your family and seeks a better life for all, you understand the importance of a college education for your children. And you know that, next to buying a home, a college education is the largest expenditure most parents will ever make. According to the College Board, for the 2019-2020 academic year, the average annual cost for a four-year public college is $21,950 (in-state students) and for a four-year private college, $49,870. (These are numbers for tuition, fees, room, and board).

It’s likely that costs will continue to rise, but by how much? Annual increases in the range of 2 to 5% would be in keeping with historical trends. But keep in mind that the actual percentage increase in any year could be higher or lower, and the rate could vary from public to private college.

The Importance of Saving Early

The more money you save now, the less money your child will need to borrow later. By investing even a small amount on a regular basis, you have the potential to accumulate a significant amount in your child’s college fund.

The following table illustrates how your monthly investment could grow over time (assuming an 8 percent after-tax):

Monthly Investment 5 Years 10 Years 15 Years 20 Years
$100 $7,348 $18,295 $34,604 $58,902
$300 $13,043 $54,884 $103,811 $176,706
$500 $36,738 $91,473 $173,019 $294,510
Note: This example is for illustrative purposes only and does not represent the return of any investment. There is no guarantee that your investment will realize a return, and there is a risk that you could lose your investment entirely.

Key Education Savings Numbers

Coverdell education savings accounts (formerly known as education IRAs)

Coverdell ESAs 2019 2020
Annual contribution limit $2,000 $2,000
MAGI phaseout range for Coverdell education savings accounts 2019 2020
Single–phaseout threshold amount $95,000 $95,000
Single–completed phaseout amount after $110,000 $110,000
Married filing jointly–phaseout threshold amount $190,000 $190,000
Married filing jointly–completed phaseout threshold amount $220,000 $220,000

Gift tax exclusion

Gift tax 2019 2020
Annual gift tax exclusion–single individual $15,000 $15,000
Annual gift tax exclusion–joint gift $30,000 $30,000
Lump-sum gift to 529 plan–single individual $75,000 $75,000
Lump-sum gift to 529 plan–joint gift $150,000 $150,000

Kiddie tax

The Tax Cuts and Jobs Act of 2018 simplified the kiddie tax; it will stay in effect until 2025. As in previous years, a child is allowed $2,100 in untaxed, unearned income. Amounts over the $2,100 threshold are taxed at these rates:

Up to $2,500: 10%
$2,551 to $9,150: 24%
$9,151 to $12,500: 35%
All over $12,501: 37%

The good news is that kids are no longer affected by their parent’s tax rate. Plus, parents no longer have to worry about adding the earnings of several siblings together.
Be careful because the new rates could be higher than a parent’s highest tax rate under the new tax code. However, a married couple would have to have over $600,000 in income to reach the highest kiddie tax rate of 37%.

Example: In 2017, a child has unearned income of $5,000. They would have paid 0% on the first $2,100. Then on the remaining $2,900, they would pay $1,148 in taxes if the parent’s tax bracket was 39.6%.

In 2018 or 2019, a child who has that same amount in unearned income would again pay 0% on the first $2100. The tax would be 10% on the next $2,500 or $250 and then 24% on the remaining $400 or $96. That’s a tax bill of $346 compared with $1,148 in 2017.

Note: Azzad Asset Management does not provide tax or legal advice.